Except in cases where financial assets meet both the ‘hold to collect business model’ and SPPI (solely payments of principal and interest) tests, and are therefore classified and measured at amortised cost, IFRS 9 Financial Instruments otherwise requires financial assets to be measured at fair value. Fair value movements are usually recognised in profit or loss, however, in some cases, they are recognised in other comprehensive income (OCI) and classified as being at fair value through other comprehensive income (FVTOCI).

In this article we highlight two cases where FVTOCI cannot be used, i.e. for:

Equity instruments that do not meet the definition of equity in IAS 32, and

Derivatives.

In most cases, fair value movements are recognised in profit or loss. However:

If the instrument is …

It may be measured at…

If…

A debt instrument of the counterparty

Fair value through other comprehensive income (FVTOCI) with recycling allowed

It meets both:

The contractual cash flow characteristics test, and

The hold to collect and sell business model test

IFRS 9, paragraph 4.1.2A

An equity instrument of the counterparty

Fair value through other comprehensive income (FVTOCI) with no recycling allowed

It :

Is not held for trading, and

An irrevocable election is made at initial acquisition to present fair value movements in other comprehensive income (OCI)

IFRS 9, paragraph 4.1.4

Measuring fair value movements in other comprehensive income (OCI) for investments in debt instruments is mandatory.

However, entities can choose on initial recognition, by making an irrevocable election on an investment-by-investment basis, to present fair value movements in OCI for investments in equity instruments that are not ‘held for trading’.

Where this occurs:

Such investments are recognised at fair value

Movements in fair value are presented in OCI

Dividends received from these investments are recognised as income in profit or loss, and

Fair value movements accumulated in OCI are not reclassified to profit or loss on disposal, but can be transferred to other categories within equity.

Example

On 1 July 2016, Entity A invests $10,000 in 1,000 units of Mutual Fund that invests in listed shares. Unitholders can ‘put’ the units (i.e. redeem the units) back to Mutual Fund at any time.

An equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.

Mutual Fund’s units do not meet the definition of ‘equity instruments’ because Mutual Fund has an obligation to pay out cash if investors ‘put’ their units back to it for an amount that equates to their share of the net assets of the fund. However, Mutual Fund’s units are classified as ‘equity’ in its financial statements because they meet the provisions of IAS 32, paragraphs 16A-B.

Question 1

Is Entity A permitted to irrevocably designate its investment in units of Mutual Fund at FVTOCI under the FVTOCI option contained in IFRS 9, paragraph 4.1.4?

Answer

No.

To be eligible for the election under IFRS 9, paragraph 4.1.4, the investment must be an ‘equity instrument’ as defined in IAS 32, i.e. a residual interest in the assets of an entity after deducting all of its liabilities.

The IFRS Interpretations Committee (Committee) concluded in its meeting in September 2017 that only equity instruments that meet the definition of equity under IAS 32 are eligible for this election.

The Committee further clarified that equity instruments meeting the definition of equity solely because of the specific provisions of IAS 32, paragraphs 16A-B, or 16 C-D are not eligible, because absent the provisions, these instruments would normally not meet the definition of equity.

Because these units are not equity instruments, Entity A would:

Firstly, assess whether they should be measured at amortised cost (which is unlikely since investments in a unit trust would fail the SPPI test because they do not give rise to payments of principal and interest consistent with a basic lending arrangement), and

Secondly, conclude that these investments should instead be measured at fair value through profit or loss (FVTPL).

Question 2

The fair value of these units on 30 June 2017, 2018 and 2019 are as follows:

Fair value

30 June 2017

$12,500

30 June 2018

$15,000

30 June 2019

$13,000

Under IAS 39, Entity A classified this instrument as ‘available-for-sale'.

Entity A transitions to IFRS 9 on 1 July 2018 and has chosen not to restate prior periods.

What is the transition journal entry to be processed by Entity A on transition date, 1 July 2018?

Answer

The carrying amount of the investment on 30 June 2018 (transition date) under IAS 39 is $15,000, with $5,000 recognised in accumulated OCI (comprising the $15,000 available-for-sale investment at fair value less $10,000 cost).

No measurement adjustment is required on transition because the investment is measured at fair value under both IAS 39 and IFRS 9. However, Entity A would need to reclassify $5,000 from accumulated OCI to retained earnings on transition:

1 January 2018

Dr($)

Cr($)

Accumulated OCI

5,000

Opening retained earnings

5,000

Question 3

What are the journal entries for the year ended 30 June 2019?

Answer

As Entity A measured its units in Mutual Fund at FVTPL, it recognises a loss of $2,000 in profit or loss, being the fair value movement of the units from $15,000 at 30 June 2018, to $13,000 at 30 June 2019.

30 June 2019

Dr($)

Cr($)

Profit or loss

2,000

Investment in Mutual Fund units

2,000

Note:

Some options are classified as ‘equity instruments’ of the issuer but are nevertheless, derivative financial instruments (for example, if ABC Ltd holds an option that allows it to purchase 100 shares in XYZ Ltd for $5 per share).

The FVOTOCI measurement category for equity instruments is only available for equity instruments that are non-derivatives. Although this option meets the ‘fixed for fixed’ criteria under IAS 32 for equity classification from XYZ Ltd’s perspective, it does not qualify for the FVTOCI measurement category from the investor’s perspective because the option is a derivative instrument. ABC Ltd must therefore account for the option at FVTPL.